You might hear auditing described as ‘a necessary evil’ or that businesses ‘just have an audit because they have to’, or even that it is a needless overhead - but audits can add real value as Jonathan Moughton, a Partner at Haines Watts explains.
Auditing has been under intense scrutiny lately after a number of high-profile audit failures, including the furore over Carillion. Auditors often get the blame for business failure, but it is the non-executive directors of large corporates who should be the front line of defence, not the auditors in my opinion.
It’s clear that big firms and big failures have shone a spotlight on the audit world and this has led to:
- Increased regulation of audits for everyone
- Plans to break up the dominance of the Big Four
The upshot is we are now having to jump through increasingly difficult regulatory hoops, which also means the added value part of auditing is coming into sharper focus.
There are many textbook reasons why a business owner will have an audit but in practice it can give them a far better understanding of their business - so long as the audit is done properly and with an auditor who understands their aims. There are various ways in which an audit adds significance to a business, including affecting enterprise value.
What is enterprise value?
Enterprise value is what your business is worth. If you are selling your business there are a number of things that you would do to build enterprise value, by getting the best multiple of profits possible.
The end goal of every business owner is to own a valuable business, whether you are building to sell, building to hand over to the next generation or just to have a more successful business.
From an auditors’ perspective, systems and controls are the lifeblood of a successful, scalable company and there can be a drag on enterprise value without the right systems or controls in place. A good audit should be able to identify these.
If you are looking to sell a business and your accounts have been audited, that can provide reassurance to a potential purchaser. It may also reduce the amount of due diligence a purchaser might seek to do because there has been regular external scrutiny of the figures.
Businesses are generally assessed on the basis of a multiple of profits and that can be impacted by a whole load of variables across the business. One of the key variables that impacts that multiple is risk.
How does an audit help you identify risk?
First and foremost, an audit is stating your accounts show a true and fair view of the business. However, an audit should also flag weakness and risk in a business so the owners can take corrective action, reduce the risk and ultimately increase business worth.
Our clients know their businesses very well but, in my experience, they value the external perspective that comes from having an audit because the audit team will have been ‘under the bonnet’ of several similar sized businesses with similar issues. They can always tell me how much money they have earned, but they don’t always look at the detail around their systems and controls.
If you have an audit team that has a commercial perspective, it can and should highlight other things that affect risk. The information an audit takes into account and the systems it has to use to get that information can highlight issues around commercial contracts or dependence on key staff, customers and maybe even suppliers. It should also show weaknesses in your systems and processes.
The purpose of an audit report
An audit means different things to different people, depending on the type of business. For a company looking for funding, it is about reassuring potential funding providers of the integrity of their finances. For trustees of charities and not-for-profit businesses, it is about good governance and rigour around internal processes as they are not involved in day-to-day operations. Indeed, the original thrust of an audit report was to reassure shareholders about the financial information being prepared by the directors – and that remains the case with large corporates - but in an owner-managed business the shareholders and directors are the same people.
Recently, I had a conversation with an owner-manager who had been audited. He said: ‘As a director, I am happy because the audit was all very simple and straightforward, but as a shareholder, I didn’t really feel that my running of the business had been questioned enough.’
Are your processes up to the job?
Any change can put pressure on the business operations. If we look at digital transformation of a business, for example, - or rapid growth over a short period of time - the change can add stress to systems. There are a lot of businesses in our client base who have had to invest in new systems because their businesses have grown significantly and they have had to keep pace with that growth. Sometimes people are so busy with running the business that they don’t see systems are under strain and that can cause issues later.
If you are looking at an audit commercially and are questioning those internal processes, you should be able to identify something that doesn’t add up. You should also identify deficiencies in the system and suggest areas where they could improve.
The role of the auditor
There is a real responsibility on an auditor to challenge management. They need to say to a business owner that, while they have assumptions about their business processes, let’s hold a mirror up to them and reflect on whether those assumptions are right and whether their systems are fit for purpose in the context of your business strategy for the future.
It is clear that an audit is an invaluable tool helping you as an owner to manage commercial risk because it should highlight issues and opportunities for improvement. We are now looking at using data analytics on our clients’ financial information. That technology will enable us to present financial information to clients in ways they don’t usually see, which can only help them get an alternative perspective on their business.